Credit Crunch: The Sequel

The failure of Eurozone leaders to arrive at a credible solution to shore up the single currency bloc is threatening to hit the rewind button and plunge the banking system into a fresh bout of paralysis at least as bad as the credit crunch of 2008.

A humble Franco-Belgian municipal lender, Dexia, has found itself the unwilling star of what is threatening to turn into a disaster movie, Credit Crunch: The Sequel.

In itself, the situation at Dexia is worrying enough.

'For generations to come, people will say: thank God Britain didn't join the Euro.' announced Osborne.

The bank has been unbalanced by its large exposure to Greek sovereign, private and corporate debt, which at around 4.8bn euros in total, is bigger than its battered market capital.

Dexia which has been involved in private finance initiative projects in the UK, is now moving towards a break-up supported by the French and Belgian authorities, which already have stakes following an earlier rescue three years ago.

But its plight is indicative of wider and deeper flaws.

The Belgian government, which is providing support for the Brussels-based group, does not actually exist – that country is being run by a caretaker prime-minister.

Few Belgians seem traumatised by their lack of a government, and few non-Belgians seem to have even noticed.

In the context of the bickering and indecision of the other Eurozone leaders, I am not sure whether this strange political situation is terrifying or simply irrelevant.

Dexia’s downfall also highlights the implausibility of official reassurances. It passed a supposedly stringent ‘stress-test’ as recently as July this year – which cannot help but set markets wondering how many others with an apparently clean bill of health are on the sick list.

The response of the Eurozone’s elite to the ravages inflicted on bank shares has been yet more prevarication, namely delays to moves to release funding for Greece.

They seem oblivious to the gravity and enormity of events unfolding in front of their eyes.

As the leaders dithered, Deutsche Bank, until recently seen as the epitome of Teutonic solidity, issued a warning that its profits would be lower than hoped, blaming market turmoil and bigger losses on Greek loans.

Matters were not helped by a gloomy note from economists at Goldman Sachs, who have downgraded their forecasts for the euro area due to ‘financial dislocations’ and are predicting a return to recession at the turn of the year.

Worries over the possibility Eurozone banks may have to take large losses on Greek debt – and possibly Portuguese, Irish and other loans to fiscally-challenged governments – have made it harder for them to borrow both long and short term funds.

The banking system had been reliant on cheap dollar funding but that well has run dry, to the point where central banks recently had to step in – albeit at a price.

Lenders in Europe urgently need to bolster their capital buffers, but as investors head for the hills, that is becoming more expensive and more difficult to do.

Needless to say the crisis is spreading beyond the Continent itself. Shares in RBS fell yesterday after its chief executive said market turmoil was hampering its recovery, and the cost of insuring debt for Wall Street titans Morgan Stanley and Goldman Sachs rose to levels not seen since 2008.

The eurozone’s leadership has been sleepwalking into another financial catastrophe. They are about to get a very rude awakening.